Why $75 Benchmark Price for budget 2013 id right for Nigeria

Below explains how the $75 benchmark price was arrived at, the dangers of an overly high benchmark price, relevant examples from other countries and related issues. – Why $75 Benchmark Price for Budget 2013 Is Right for Nigeria

An overly high benchmark price likely to lead to higher inflation, decline in the value of the naira, lower savings and reduced investment.

How did we arrive at budgeted oil price of $75/barrel? In line with the oil-price based fiscal rule (see Fiscal Responsibility Act, 2007), we chose a prudent oil benchmark price of $75/barrel for the 2013 period. This is below current world market prices and based on moving averages of the world oil price and government’s simulations allowing for uncertainty in world oil price movements. We used the model to estimate 5-year and 10-year moving averages of the oil price and arrived at our own average of approximately $71/barrel, which was then rounded up to $72/barrel (the 2012 Budget Level). This is a standard technique commonly used by commodity-dependent countries to protect them against the volatilities of oil. Following consultations with various stakeholders including Governors and the National Assembly, it was agreed that the benchmark price should be further rounded up to $75/barrel to meet pressing needs and prevent delays in the budget process. This $75/barrel price represents an upper limit from our model, if Nigeria is to maintain a stable macroeconomic environment for next year.

Why the $80/barrel price proposal would be harmful for the Nigerian economy.

First, it would lead to an increase in liquidity, and be harmful for many of the Government’s macroeconomic forecasts. Based on our estimates, inflation rates would certainly rise significantly. The exchange rate would come under severe pressure, leading to a depreciation of the Naira. High inflation would result in higher interest rates. A combination of high inflation, interest rate and an unstable exchange rate is bad for economic planning, both for the government and for private businesses. Overall, we know that macroeconomic volatility is bad for growth (see Figure 1).

Second, the legislature’s proposal is premised on an overly-optimistic outlook of global oil prices. The current world oil price is not based on actual economic fundamentals, but rather on uncertainties due to conflict in the Middle East. Nigeria cannot base its plan simply on the expected misfortunes of others!!!

Third, in our view, current global oil prices are not sustainable. There are two reasons for this: (a.) possible reduction in global oil demand, due to recession in the Eurozone, low growth in the US, and economic slowdown in the China and India, (b.) increased global oil supply as new discoveries in Africa and elsewhere come on stream. In addition, with the end of the Libyan crises, approximately 1.6 m barrels per day would be returned to the world market.

Fourth, the legislature’s proposal would result in much lower savings in the ECA. To be precise, it would deny the ECA of significant additional inflow. These savings are necessary to cushion the impact on the Nigerian economy, in the event of a global economic recession or a slump in world oil prices. Recall that, in 2008, oil prices collapsed from about $147/barrel to $38/barrel in a few months! And at that time, Nigeria turned to its savings in the Excess Crude Account, rather than asking for humiliating sovereign bailouts from the IMF etc!

Fifth, the international investor community is closely observing fiscal developments in Nigeria. In September, the two sovereign credit rating agencies – Fitch and Standard &Poors – visited Nigeria. We expect favorable credit ratings, following up on our prudent management of public finances. Increasing the benchmark oil price could be a bad and risky signal to international markets, and may lead to foreign investors reducing their exposure to Nigeria’s financial markets. It will also make it more difficult for Nigerian Corporates to raise financing outside Nigeria as several of them plan to do in 2013.

In 2012, how did Nigeria’s benchmark oil price compare to other oil-producing countries? Nigeria had a benchmark oil price of $72/barrel in 2012, compared with budgeted prices as low as $37/barrel in Algeria.

Country Crude Oil Assumptions; US$/pb

Angola 77

Oman 75

Nigeria 72

Saudi Arabia 60

Kuwaiti 60

Qatar 55

Venezuela 50

Algeria 37

A prudent oil benchmark price would ensure that Nigeria saves more, and increases its external reserves. At present, Nigeria’s external reserves are lagging when compared with comparator countries as at June 2012. Please recall that high external reserves underpin the currency and exchange rate of any country.